When people refer to “the economy” they are generally referring to GDP. If a newsperson says, “The economy grew by 3.5 percent last year,” it means that GDP grew by 3.5 percent during the year (compared with the previous year's GDP). Incidentally, a growing economy characterizes an expansion, which is also known as a recovery. A contracting economy characterizes a recession. For now, it's important to know that a society benefits greatly from a stable, growing economy.

A growing economy generates increasing amounts of jobs, incomes, and goods and services for its citizens. All of these are good things, of course. In a contracting economy, jobs and incomes are lost and the amount of goods and services produced shrinks. This puts people out of work, and means that there are fewer goods and services to go around. A stagnant economy—one that is neither growing nor contracting—isn't much better than one that's contracting. As the population grows, people need more jobs and more goods and services, and a stagnant economy doesn't produce them.

EconoTip

Economists also refer to GDP—total spending on goods and services—as total demand. In other words, the amount of goods and services accounted for in GDP is also the amount demanded by households, businesses, and the government.

If you look at the formula for GDP, you'll see that if any one component increases, then the total GDP increases (assuming that the other components remain unchanged). For example:

If consumer spending grows—if people buy more clothing and cars and homes—then the economy grows.

If business investment grows—if companies invest in new buildings and equipment and buy more raw materials—then the economy grows.

If government spending grows—if money is poured into the space program, defense, roads, and police forces—then the economy grows.

By the same token, if any one component of GDP decreases, then total GDP decreases unless another component of the GDP increases enough to make up for the loss.